No risk, no reward. Most people intuitively understand that theyhave to bear some risk to achieve an acceptable return on theirinvestment portfolios.But how much risk is right for you? If your investments turnsour, you may put at jeopardy your ability to retire, to pay foryour kid's college education, or to weather an unexpectedneed for cash. These worst-case scenarios focus our attentionon how to manage our exposure to uncertainty.Assessing and quantifying-risk aversion is, to put it mildly,difficult. It requires confronting at least these two big questions.First, how much investment risk can you afford to take?If you have steady high-paying job, for example, you havegreater ability to withstand investment losses. Conversely, ifyou are close to retirement, you have less ability to adjust yourlifestyle in response to bad investment outcomes.Second, you need to think about your personality anddecide how much risk you can tolerate. At what point will yoube unable to sleep at night?To help clients quantify their risk aversion, many financialfirms have designed quizzes to help people determine whetherthey are conservative, moderate, or aggressive investors.These quizzes try to get at clients' attitudes toward risk andtheir capacity to absorb investment losses.Here is a sample of the sort of questions that can shed lighton an investor's risk tolerance.MEASURING YOUR RISK TOLERANCECircle the letter that corresponds to your answer.1. The stock market fell by more than 30% in 2008. If you hadbeen holding a substantial stock investment in that year,which of the following would you have done?a. Sold off the remainder of your investment before it hadthe chance to fall further.b. Stayed the course with neither redemptions norpurchases.c. Bought more stock, reasoning that the market is nowcheaper and therefore offers better deals.2. The value of one of the funds in your 401(k) plan (your pri-mary source of retirement savings) increased 30% last year.What will you do?a. Move your funds into a money market account in casethe price gains reverse.b. Sit tight and do nothing.c. Put more of your assets into that fund, reasoning that itsvalue is clearly trending upward.3. How would you describe your non-investment sources ofincome (for example, your salary)?a. Highly uncertainb. Moderately stablec. Highly stable4. At the end of the month, you find yourself:a. Short of cash and impatiently waiting for your nextpaycheck.b. Not overspending your salary, but not saving very much.c. With a comfortable surplus of funds to put into your sav-ings account.5. You are 30 years old and enrolling in your company'sretirement plan, and you need to allocate your contribu-tions across 3 funds: a money market account, a bondfund, and a stock fund. Which of these allocations soundsbest to you?a. Invest everything in a safe money-market fund.b. Split your money evenly between the bond fund andstock fund.c. Put everything into the stock fund, reasoning that by thetime you retire, the year-to-year fluctuations in stock,returns will have evened out.6. You are a contestant on Let's Make a Deal, and have justwon $1,000. But you can exchange the winnings for tworandom payoffs. One is a coin flip with a payoff of $2,500if the coin comes up heads. The other is a flip of two coinswith a payoff of $6,000 if both coins come up heads. Whatwill you do?a. Keep the $1,000 in cash.b. Choose the single coin toss.c. Choose the double coin toss.7. Suppose you have the opportunity to invest in a start-upfirm. If the firm is successful, you will multiply your invest-ment by a factor of ten. But if it fails, you will lose everything.You think the odds of success are around 20%. How muchwould you be willing to invest in the start-up?a. Nothingb. 2 months' salaryc. 6 months' salary8. Now imagine that to buy into the start-up you will need toborrow money. Would you be willing to take out a $10,000loan to make the investment?a. Nob. Maybec. Yes

As per the Honor code of Bartleby we are bound to given the answer of First Question only, Please…

No risk, no reward. Most people intuitively understand that they have to bear some risk to achieve an acceptable return on their investment portfolios. But how much risk is right for you? If your investments turn sour, you may put at jeopardy your ability to retire, to pay for your kid's college education, or to weather an unexpected need for cash. These worst-case scenarios focus our attention on how to manage our exposure to uncertainty. Assessing and quantifying-risk aversion is, to put it mildly, difficult. It requires confronting at least these two big questions. First, how much investment risk can you afford to take? If you have a steady high-paying job, for example, you have greater ability to withstand investment losses. Conversely, if you are close to retirement, you have less ability to adjust your lifestyle in response to bad investment outcomes. Second, you need to think about your personality and decide how much risk you can tolerate. At what point will you bo unable to sloop at night2 4. At the end of the month, you find yourself: a. Short of cash and impatiently waiting for your next paycheck. b. Not overspending your salary, but not saving very much. c. With a comfortable surplus of funds to put into your sav- ings account. 5. You are 30 years old and enrolling in your company's retirement plan, and you need to allocate your contribu- tions across 3 funds: a money market account, a bond fund, and a stock fund. Which of these allocations sounds best to you? a. Invest everything in a safe money-market fund. b. Split your money evenly between the bond fund and stock fund. c. Put everything into the stock fund, reasoning that by the time you retire, the year-to-year fluctuations in stock,

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS